Tax Update for the N.E. ACA Conference. Jeff Solomon, Managing Partner, KN+S

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1 Tax Update for the N.E. ACA Conference Jeff Solomon, Managing Partner, KN+S

2 Katz Nannis + Solomon, PC Boutique, regional CPA firm focused on entrepreneurial companies with an emphasis on technology Much more than taxes! Work mostly with Angel and Venture backed Companies, Funds and family offices Work on Audits, Reviews and Corp. tax planning and set up Assist in negotiations and sales of companies at Exit Qualified professionals in tax and audit that know equity, revenue recognition and provide creative tax planning ideas We focus on the types of Companies YOU invest in and we can help them AVOID disasters down the road 45 Professionals, located on RT. 128 in Needham Will meet with any of your companies in an introductory meeting free of charge 2

3 TAX PLANNING BASICS Tax planning shouldn t be just a year end activity Keep in mind that the Bush Tax Cuts expire in

4 It all happens in 2013 Rates go up New Surtax on investment income- Unearned income Medicare Contribution tax =3.8% of the lesser of 1) net investment income or 2) the amount by which modified AGI exceeds $250,000(mfj) An additional.9% on Wages if they are over $250,000 (Instead of 1.45% now 2.35% of Medicare tax) Long-term capital gains and qualified dividends taxed higher rates Estate taxes potential much higher 4

5 KNS OUTLOOK OF INCREASE IN RATES (and don t forget state taxes!) OUTLOOK OF HOW TAX RATES WILL INCREASE FOR PERSONAL INCOME FROM 2011 TO 2013 IF CONGRESS DOES NOTHING ACTIVE INCOME QUALIFIED PASSIVE FROM FROM WAGES LTCG DIVIDENDS INCOME GP S CORP HIGHEST TAX BRACKET 35.00% 15.00% 15.00% 35.00% 35.00% 35.00% MEDICARE/SE TAX ON EARNED INCOM 1.45% 0.00% 0.00% 0.00% 2.90% 0.00% 2011 AND 2012 HIGHEST MARGINAL RATES 36.45% 15.00% 15.00% 35.00% 37.90% 35.00% EXPIRATION OF TAX CUTS IN % 5.00% 24.60% 4.60% 4.60% 4.60% 2013 HIGHEST MARGINAL RATES 41.05% 20.00% 39.60% 39.60% 42.50% 39.60% NEW MEDICARE/HI TAX EFFECTIVE IN % 3.80% 3.80% 3.80% 0.90% 0.00% 2013 TOP RATE 41.95% 23.80% 43.40% 43.40% 43.40% 39.60% INCREASE FORM 2011 TO % 8.80% 28.40% 8.40% 5.50% 4.60%

6 The Rates ARE GOING UP!!! Through 2012, long-term capital gains rate and qualified Dividends will remain at 15% In 2013 they will increase to 20% and all dividends will be at your highest marginal rate(39.6%vs 15% TODAY) 6

7 AMT-GUESS WHAT-YOU ARE NOT ALONE!!! State and local income tax deductions Real estate and personal property tax deductions Interest on home equity loan or line of credit not used to buy, build or improve your principal residence Miscellaneous itemized deductions subject to 2% of AGI floor Long-term capital gains and dividend income Accelerated depreciation adjustments and related gain or loss differences when assets are sold Tax-exempt interest on certain private-activity municipal bonds Incentive stock option exercises 7

8 Avoiding AMT or reducing its impact Planning for AMT will be a challenge until Congress passes long-term relief AMT system isn t regularly adjusted for inflation Congress legislates adjustments, typically as a patch 2012 not yet 8

9 Employment taxes Social Security and Medicare taxes Apply to earned income, such as salary and bonuses For 2012 At least through February 29 th tax is still at 4.2% If not extended, Social Security tax will be back to 6.2% May be a recapture provision of the 2% Maximum taxable wage base for Social Security taxes is $110,100 STAY TUNED ON THIS ONE-SHOULD BE ANY DAY NOW. Warning! All earned income is subject to the 2.9% Medicare tax 9

10 Owner-employees Partnerships and limited liability companies Trade or business income is subject to self-employment tax Even if income isn t actually distributed to you Income isn t taxed if you re limited partner or LLC member S corporations Only income received as salary subject to employment tax Reduce tax by keeping salary low and increase distributions of company income (generally not taxed at corporate level) To avoid back taxes and penalties, salary must be reasonable C corporations Only income received as salary is subject to employment tax 10

11 KN+S IDEAS FOR ANGELS AND INVESTORS IN START UPS HAVE A GREAT TAX ADVISOR AND BUSINESS PARTNER HELPING YOU-ITS GOING TO COUNT MORE THAN EVER AFTER THIS YEAR For instance-should you start to convert some of your corporate bonds to tax free bonds to avoid the 3.8% tax on investment income.. What will this do to the market place??

12 Capital gains tax and timing Time not timing is generally the key to long-term investment success Timing can have a dramatic impact on tax consequences of investment activities 12

13 Loss carryovers Capital losses are netted against capital gains to determine capital gains tax liability Deduct up to $3,000 of losses per year against ordinary income Carry forward excess losses to future years(no LIMIT) Lot of planning should be done between your CPA and financial advisor Determine if you have excess losses Time sales of other investments before year end to achieve your tax-planning goals 13

14 ANGELS-FYI-Small business Loss benefits(1244 stock) If you invest in a Small Business (domestic corp., original issue to you, capital invested at time < $1mm, active trade or business) UP TO $50,000 OR $100,000 SINGLE AND MFJ RESPECTIVELY CAN BE TREATED AS AN ORDINARY LOSS(NOT A CAP LOSS!)

15 Small business stock STOCK Enjoy preferential tax treatment Convert capital losses to ordinary losses Defer tax on gain Exclude up to 50% of gain (must hold the stock for at least five years) What types of Corps qualify? Depending on acquisition date, exclusion may be 75% or 100%(AT END OF 2011) Rolls back to 50% in 2012 AT THE 50% EXCLUSION THE REAL BENEFIT GOES AWAY DUE TO AMT!!! PS-THE PAYROLL TAX EXTENDER HAS THIS 100% EXCLUSION TIED TO THE BILL!! STAY TUNED 15

16 ANGELS-DID YA KNOW ABOUT SECTION 1045 ROLLOVER GAINS? LETS CHAT In the case of of any sale of a qualified small business stock(<$50mm capitalization and active trade/business-c corp) that you have held for more than 6 months You can Rollover the gain into the cost of any new qualified small business If you Invest in the new business within 60 days You can invest in several small business companies-doesn t have to be just 1! Your fund or partnership can be eligible to do this! Make election on your Schedule D by writing section 1045 rollover on the line showing the gain and then back out the gain on a separate line!

17 Understanding depreciation MACRS Generally more advantageous than straight-line method Larger deduction in early years of asset s life Bonus depreciation 50% bonus depreciation for qualified assets placed in service from Jan. 1, 2008, through Sept. 8, % bonus depreciation for assets placed in service from Sept. 9, 2010, through Dec. 31, % bonus depreciation for assets placed in service from Jan. 1, 2012, through Dec. 31, 2012 No bonus depreciation after Dec. 31,

18 Section 179 expensing election Allows you to write off rather than depreciate asset purchases Deduct up to $500,000 of purchases Deduction phases out dollar-for-dollar when 2011 asset purchases exceed $2 million Limits are scheduled to go down in 2012 ($139,000) Only Section 179 expensing can be applied to used assets 18

19 19 Manufacturers deduction and R&d Credits MFG DEDUCTION Deductible amount is 9% of the lesser of qualified production activities income or taxable income, limited by W-2 wages paid Available also to businesses engaged in nonmanufacturing activities, such as Construction and EngineeringEngineering Architecture Computer software production(many miss this!) Agricultural processing Deduction can be used against the AMT R&D Credit-RIGHT NOW EXPIRED IN 2012 BUT STAY TUNED ANGELS-IN THE EXTENDER BILL Often overlooked Improvements or enhancements to new or existing products

20 More tax breaks NOL deduction NOL can be carried back two years to generate current tax refund Any loss that s not absorbed is carried forward up to 20 years Additional rules apply Tax credits Research credit extended through 2011 Elections exist to make it refundable Work Opportunity credit extended through 2011 Equals 40% of first $6,000 of wages paid to qualified employees $12,000 for wages paid to qualified veterans HIRE Act retention credit available through 2011 Workers must be retained for 52 consecutive weeks 20

21 Health care tax credit Through 2013 Available for employers with 10 or fewer FTEs, who on average earn less than $25,000 per year Partial credits available to businesses with fewer than 25 FTEs, who on average earn less than $50,000 Credit amount Maximum credit is 35% of premiums paid by employer Employer must contribute at least 50% of total premium 21

22 Exit planning Strategy to pass responsibility for running the company, transferring ownership and extracting money from the business Warning! Requires planning well in advance of the transition 22

23 Sale or acquisition Tax consequences can have a major impact on the transaction s success or failure Common types of transactions Asset or stock sale TRENDS WE HAVE SEEN? Taxable sale vs. tax-deferred transfer 23

24 Executive compensation Incentive stock options Buy company stock in the future at fixed price equal to or greater than stock s FMV at grant date Don t provide benefit until stock appreciates in value Key tax consequences Owe no tax when ISOs are granted Owe no regular income tax when you exercise the ISOs Additional tax consequences may occur depending on when you sell the stock DON T FORGET THAT 409a VALUATION? MUST YOU GET IT? YES Warning! In the year of exercise, a tax preference item is created on the difference between the stock s FMV and the exercise price; this can trigger the AMT. A future AMT credit may lessen this AMT hit. 24

25 Executive compensation Nonqualified stock options Tax treatment differs from ISOs NQSOs create compensation income on bargain element when exercised Don t create an AMT preference item May need to make estimated tax payments or increase withholding to cover tax on the exercise Consider state tax estimated payments 25

26 Executive compensation Restricted stock Granted subject to substantial risk of forfeiture Income recognition normally deferred until stock is no longer subject to risk or you sell it You pay ordinary-income taxes based on stock s FMV when restriction lapses Consider using Sec. 83(b) election to recognize ordinary income when you receive stock Make election within 30 days after receiving stock Allows you to convert future appreciation from ordinary income to long-term capital gains income Defers it until you sell the stock Keep in mind: Any taxes you pay can t be refunded if you forfeit the stock or its value decreases 26

27 Transfer tax exemptions and rates What will happen in 2013 really? Will there be a claw back?? hmmm-maybe? Take advantage of the $5mm exemption limit NOW in 2012!!!! Talk to your estate attorney now or talk to KNS! 27

28 OTHER ISSUES TO KEEP IN MIND CHOICE OF ENTITY NOW? C CORPS BACK IN VOGUE? BE WARY OF WARRANTS ISSUED AND TRICKS ON ACCOUNTING FOR THOSE IS YOUR 409A VALUATION UP TO DATE? HOW OFTEN DO I NEED TO UPDATE? IS DEFERRED OFFICER SALARY REALLY OK TO USE? ISSUES? IS CONVERTIBLE DEBT INTEREST TAXABLE WHEN I CONVERT TO STOCK? OTHER QUESTIONS?

29 Thank you for attending Please contact me for assistance: If you want a copy of this presentation please see us at the break or give us a business card!!!